Backdoor Roth IRA 2024: 3 Simple Steps (2024)

What is a Backdoor Roth IRA?

A backdoor Roth IRA is a way to accumulate money in a Roth even if you’re no longer eligible to contribute to a Roth IRA. First, you start off by contributing money to a traditional IRA. This contribution is made with after-tax dollars so you don’t receive a tax deduction for it. Then you do a backdoor Roth conversion to a Roth IRA. You pay taxes on the earnings (not the contributions). From there, your investments can flourish tax-free, allowing for tax-free withdrawals in the future. It’s completely legal and very simple!

How does a Backdoor Roth IRA work?

Step One: Contribute to a Traditional IRA.

This is pretty straightforward. You can do this through any brokerage firm (Vanguard, Fidelity, etc) as this choice is of no significant impact. You have the option of making the maximum contribution for that year ($7,000 in 2024; $8,000 if you’re age 50 or older).

Step Two: Move your pre-tax IRAs to your current employer plan.

Many people willingly neglect this step, which can lead to a huge tax bill. If you have a rollover IRA that came from an old employer plan (401(k), SEP IRA, etc), it is time to move these to your current employer retirement plan. You may be wondering what that has to do with a backdoor Roth IRA. It has to do with the IRS aggregation rule.

Example: Let’s say you have $95,000 in a rollover IRA. Congratulations on saving that much from your previous job! Now let’s assume you just contributed $5,000 into your new non-deductible traditional IRA. You now have a total of $100,000 in traditional IRA money, 5% of which represents your non-deductible IRA, and 95% of which represents previously tax-deducted contributions.

Now, if you do a Roth conversion of that $5,000 (you convert this money from traditional to Roth), the IRS will treat it as if you just converted part of your rollover IRA. So, in this example, you just converted 5% of your total IRA money, most of which was tax-deductible when you contributed, so when you convert to Roth, the IRS wants their cut. This could generate an unnecessary tax bill, which we obviously don’t want.

Step Three: Convert your traditional IRA to a Roth IRA

We recommend you consider doing this step several months after you contribute to your IRA. The reason for this is that the U.S. Tax Court follows a rule called the Step-Transaction Doctrine, which sounds really boring. Essentially this doctrine says that if you do all of these steps consecutively (contribute to a Traditional IRA, and then convert it to a Roth the next day), they will see it as one single transaction.

In this case, that would mean you are contributing to a Roth IRA when you are no longer allowed, and they will slap a penalty on this transaction. You don’t want to risk that! This 12-month rule is not a hard and fast rule. Some financial advisors think that waiting one month is sufficient, so this is really up to you. This precautionary step can help ensure compliance with IRS regulations and safeguard your financial plan. While waiting to do the backdoor Roth conversion, it is best to invest thatmoney to avoidtriggering the IRS step transaction doctrine.

Doing the Roth conversion can be really simple. In Vanguard, for example, there is a button that says “convert to Roth IRA.” So, you just click on that and follow the instructions. In Fidelity, you have to do some searching. Every brokerage firm will handle it slightly differently, but it should not be an overly difficult process.

Now, when asked about tax withholding, you can choose to not withhold taxes so you have more money going into your Roth IRA when you convert. Once you complete the conversion process, you now have a Roth IRA! You can simply repeat these three steps each year to continue growing tax-freeretirement money.

If your income is above the limit, then you cannot make a Roth IRA contribution. However, you can still make a contribution to a traditional IRA, and then convert it to a Roth IRA using the backdoor Roth IRA strategy.

> Wondering if you can make a Backdoor Roth IRA contribution? Find out here!

Backdoor Roth IRA Eligibility

To be eligible for a Backdoor Roth IRA, you must first be eligible to make a Traditional IRA contribution. There are no income limits for contributing to a Traditional IRA.

Once you contribute to your traditional IRA, you can convert these funds to a Roth IRA using the Backdoor Roth IRA strategy. Therefore anyone who is eligible to make a traditional IRA contribution is eligible to do a backdoor Roth IRA. It is not necessary to do a backdoor Roth IRA if you are still eligible to contribute to a Roth IRA.

Who should consider a Backdoor Roth?

A Backdoor Roth may be a good option for people who have maxed out their traditional IRA contributions or who are not eligible to contribute directly to a Roth IRA.

Some situations where a Backdoor Roth IRA may be a good option include:

1. High-income earners: If you earn too much to qualify for a Roth IRA, then you can use the Backdoor Roth IRA strategy to contribute to a Roth IRA.
2. Maxed-out traditional IRA contributions: If you have maxed out your contributions to a traditional IRA but want to save more, then a Backdoor Roth IRA can allow for additional tax-free growth.
3. Retirement savers who are in a lower tax bracket now: If you think that you will be in a higher tax bracket during retirement, then a Backdoor Roth IRA can be used to pay taxes on your contributions now.

Who might not benefit from a Backdoor Roth?

Backdoor Roth IRA 2024 deadline

When should I contribute to a Backdoor Roth?

Can I do a Backdoor Roth every year?

What is the pro-rata rule for Roth conversion?

The pro-rata rule is a rule that applies when you convert funds from a traditional IRA to a Roth IRA, including when using the Backdoor Roth IRA strategy. The rule determines how much of the conversion is subject to income tax. If you have multiple traditional IRAs, includinga SEP IRA or a SIMPLE IRA, then you cannot choose which IRA to convert to a Roth IRA. You must include all traditional IRA balances, regardless of which account you are converting from.

The pro rata rule means that if you have both a non-deductible and a pre-tax IRA, then doing a Roth conversion will result in a tax bill. That’s because the IRS will treat a percentage of your conversion as coming from your pre-tax IRA.

The pro-rata bill can complicate the Backdoor Roth IRA. It’’s important to consult with a financial advisor to ensure you comply with the pro-rata rule.

Step #1: Contribute to a Traditional IRA

1. If you don’t already have one, open a Traditional IRA account with Fidelity. Once you have a Traditional IRA account with Fidelity, go to Transfer.
   
   
2. When asked ‘Which account do you want to move money from?’, you’ll be required to link your bank account and then proceed to select it.
   
   
3. When asked ‘Where will the money be transferred to?’ select your Traditional IRA account.
   
   
4. Next you will need to select ‘One-time’ as the occurrence.
5. The system will display the maximum allowable contribution for the year to prevent over contributing. Ensure that you contribute only up to the amount of your earned income (W2 wages or self-employed income).
   
   
6. Click on ‘Continue’
7. Review the information on the next page, and click ‘Submit’.

Step #2: Invest your contribution

1. To invest your contribution, click on ‘Trade’ at the upper left.
2. Select your Traditional IRA account, and proceed to purchase your desired ETF, mutual fund, or stock. If you make the contribution while the stock market is open (9:30 am to 4:00 pm EST), you can invest your contribution immediately. Otherwise, you may need to wait a couple of days for the funds to clear.

Step #3: Move your pre-tax IRAs to your current employer plan

Many people willingly neglect this step, which can lead to a huge tax bill. If you have a rollover IRA from a previous employer plan (such as a 401(k), SEP IRA, etc), it’s time to transfer these funds to your current employer-sponsored retirement plan. You may be wondering how this relates to a backdoor Roth IRA strategy. The connection lies in the IRS aggregation rule.

For example, let’s imagine you have $93,000 in a rollover IRA. Congratulations on saving that much from your previous job! Now let’s assume you recently contributed $7,000 into your new non-deductible traditional IRA. This brings your total traditional IRA balance to $100,000, with 7% representing your non-deductible contributions and 93% consisting of previously tax-deducted contributions.

When you execute a Roth conversion of the $7,000, the IRS considers it as a conversion from your entire IRA pool. In this scenario, you’ve effectively converted 7% of your overall IRA funds, a significant portion of which were originally tax-deductible. Consequently, when converting to a Roth IRA, the IRS expects its share, potentially resulting in an unwelcome tax obligation.

To mitigate this risk, you may want to consider transferring your pre-tax IRAs into your current employer’s 401(k) or another eligible employer-sponsored plan.

Step #4: Convert your traditional IRA to a Roth IRA

The question at hand is when to proceed with this final step. Opinions vary among financial planners, with some advising immediate action, others suggesting a month’s delay, and others recommending waiting a year.

The aim is to steer clear of any complications related to the Step-Transaction Doctrine. While the 12-month rule isn’t set in stone, some advisors advocate for a one-month waiting period as sufficient. Ultimately, the decision rests with you. During this waiting period, you may want to invest the funds to prevent triggering the IRS’s step transaction doctrine.

1. To convert your Traditional IRA to a Roth in Fidelity, go to ‘Transfer’ at the upper right.
   
2. When asked ‘Which account do you want to move money from?’, select your ‘Traditional IRA’ account.
   
3. When asked ‘Where will the money be transferred to?’, select your Roth IRA account.
4. Next you will be asking about ‘Tax Withholding Election’ You may want to choose: I elect not to have federal taxes withheld and continue my conversion online. This means that you will have more funds in your Roth that will grow tax free. (Note that you’ll have to pay taxes on the earnings you’ve made since your contribution.) Click on ‘Next.’
   
   
5. On the next screen, choose ‘Convert Entire Account Balance’, and click on ‘Leave my account open’ (since you will want to fund your Traditional IRA again). Click on Next and finish the process.
   
   
6. Once you complete the conversion process, you now have a Roth IRA! You can repeat these four steps every year to continue growing tax-free retirement money.

Backdoor Roth IRA Taxes

How do I avoid taxes on a Roth IRA conversion?

Do you pay taxes twice on a backdoor Roth IRA?

Do you pay taxes twice on a Backdoor Roth IRA?

Does the 5 year rule apply to Roth conversions?

Do you pay a 10% penalty on Roth conversions?

Is it possible to claim a deduction for my traditional IRA contribution on my tax return when converting it to a Backdoor Roth IRA?

No, you cannot deduct this contribution from your tax return.If you’re no longer eligible for a Roth IRA, you most likely are also not eligible for a traditional IRA deduction anyway. When you file your tax return, make sure your contribution is reflected onForm 8606, for non-deductible traditional IRAs.

What are the pros of a Backdoor Roth?

• Tax-free withdrawals:It can allow you to grow your money tax-free, even if you are a high-income earner.
• Tax-free growth:You pay your taxes upfront on your converted pre tax funds and then everything after that is tax-free. This benefit is greatest if you think that your tax rates will rise in the future.
• Roth IRAs don’t haveRequired Minimum Distributions(RMDs).You are not required to take minimum distributions once you reach age 72 with a Roth IRA. This is unlike traditional IRAs where the IRS mandates annual distributions.This means that the account can grow tax-deferred for as long as the account holder is alive.
• No income limits: There are no income limits for converting a traditional IRA to a Roth IRA through the backdoor method. This means that high-income earners can take advantage of this strategy.
• Flexibility: Roth IRA contributions are made with after-tax dollars which means that you can withdraw your contributions at any time without any penalties. We recommend that you leave your contributions to grow tax-free but this option is there in the case of an emergency.

What are the cons of a Backdoor Roth IRA?

The major downside to a backdoor Roth IRA is that executing it properly involves a series of steps. If you make one mistake, you might end up with a higher tax bill. Also, there is always the possibility that tax laws could change in the future which could mean that the Backdoor Roth IRA could be eliminated.

How to fix Backdoor Roth IRA mistakes

Mistake #1: Contributing directly to a Roth IRA when you’re not eligible. To fix this, you can either fill out an excess contribution form or recharacterize your Roth IRA contribution to a Traditional IRA.

Mistake #2: Forgetting to invest your Traditional IRA contribution. This is a common mistake. If you contribute to a Traditional IRA then do an immediate backdoor Roth conversion, it might be seen as a red flag by the IRS. If your contribution has been sitting in a money market fund, you can consider investing it in a diversified fund before doing the backdoor Roth conversion.

Mistake #3: Forgetting to do the Roth conversion. This is an easy one to fix. You can just go ahead and do the Roth conversion. The downside of having waited so long to convert is you will likely owe more taxes upon the Roth conversion if your Traditional IRA investments have gone up. Remember, you have to pay taxes on the earnings (not the contributions).

Mistake #4: Forgetting to move your pre-tax IRAs. This can be a costly mistake. If you convert your non-deductible Traditional IRA while you have a pre-tax IRA (e.g. SEP or Rollover IRA), then it will trigger the IRS pro-rata rule. You will end up with a higher tax bill since the IRS will view it as you have converted part of the pre-tax IRA to a Roth. Fixing this mistake is difficult.

What is a mega backdoor Roth?

A mega backdoor Roth is a retirement savings strategy that could allow you to put up to $46,000 in a Roth 401(k) in 2024, on top of your regular $23,000 annual contribution. It is basically the supersized version of the backdoor Roth IRA. The mega backdoor Roth strategy will also be eliminated if the bill proposed by the House is passed by the Senate. Creating a mega backdoor Roth is complicated. It is best to consult a certified financial planner if you want to do a mega backdoor Roth for 2024.

Can you do Backdoor Roth and Mega Backdoor Roth?

Yes, you can do a backdoor Roth and a mega backdoor Roth at the same time. To do a mega backdoor Roth, you need to have access to a 401(k) that allows after-tax contributions, and an in-plan Roth conversion option.

Is a Backdoor Roth the same as a Roth conversion?

The backdoor Roth is the name of the strategy. Roth conversion is the third step in executing the backdoor Roth strategy.

Is a Backdoor Roth legal?

Yes, the backdoor Roth IRA strategy has been legal since 2010. It is a legal and legitimate way to contribute to a Roth IRA when your income is too high to make direct contributions.

How much money can you convert from a traditional IRA to a Roth IRA?

There is no limit on how much money you can convert from a Traditional IRA to a Roth IRA. You just have to pay attention to the potential tax implications of this conversion.

Can I have 2 Roth accounts?

You can have 2 Roth accounts at the same or different institution. However, your total IRA contribution across all your IRA accounts must still be $7,000 for 2024 ($8,000 for ages 50 and older).

Is a Backdoor Roth a good idea?

If you want to save tens of thousands of tax dollars, then it may be worth your time to learn how to do a backdoor Roth properly. If you save $6,500 a year for 30 years through a backdoor Roth and grow your money by an average of 6% per year, you can potentially generate over $300,000 in tax-free money! It can also be a great idea if you earn too much to contribute to a Roth IRA.

Is a Backdoor Roth still allowed in 2024?

Yes, backdoor Roth IRAs are still allowed in 2024.

Implement a Backdoor Roth IRA strategy in 2024!

A Backdoor Roth IRA can be a valuable tool for high earners who want to take advantage of the benefits of a Roth IRA. However, consulting with a financial advisor is important to determine if a Backdoor Roth IRA is right for you. If you are interested in exploring the Backdoor Roth IRA strategy moreand are also interested in a comprehensive financial plan, we’ll be happy to help you.

Ready to maximize your finances?Schedule your free discovery call todaywith one of our fee-only financial planners.